The Bank of England has published a working paper guiding the activities of bank staff. The staff working paper outlines the various possible risks and financial vices that might pose a threat to the Central Bank Digital Currencies (CBDCs). Additionally, the result of the paper is a vital step towards understanding how the financial stability risk of CBDCs can be managed.
In the paper, the British bank proposes three models of CBDCs that differs between different sectors that have access to digital currencies; where access to CBDC is limited to banks and non-bank financial institutions (NBFIs), and finally to direct and indirect access extended to households and non-financial firms.
The Apex bank disclosed in the paper that during its market analysis, it discovered that if financial institutions follow’s the banks stated core principles, their funding is not necessarily reduced; credit and liquidity provision to the private sector, need not contract; and the risk of a system-wide run from bank deposits to CBDC is addressed.
The Proposed Core Principles for CBDCs
The core principles of the British Apex bank outlined in its paper includes:
[perfectpullquote align=”full” bordertop=”false” cite=”” link=”” color=”” class=”” size=””]
(i) CBDC pays an adjustable interest rate.
(ii) CBDC and reserves are distinct, and not convertible into each other.
(iii) No guaranteed, on-demand convertibility of bank deposits into CBDC at commercial banks
(iv) The central bank issues CBDC only against eligible securities (principally government securities) [/perfectpullquote]
As per the staff working paper, financial institutions are not supposed to provide assets directly to commercial firms and households which are supported financially by the central bank. “Households and firms must use a CBDC Exchange to buy and sell CBDC in exchange for deposits” the paper stated. Only banks and non-bank financial institutions (NBFIs) can buy or sell CBDC directly.
In this method, the CBDC can be used for financial transaction in Britain even though, it is still not recognized as an official legal tender. Notably, the bank’s analysis pointed out the role of non-bank users of CBDC, because they are the agents that determine, in conjunction with central bank policy rules, the interest rate on and quantity of CBDC. Accordingly, the non-bank users of the CBDC absorb the marginal unit of CBDC, and that, therefore, determine its convenience yield, which, given the policy rate, in turn, determines the CBDC interest rate.
Solomon Sunny is the market reporter for Smartereum, one of the global leaders in Ethereum, blockchain and currency news. He produces technical price updates on digital currencies and writes recent developments about blockchain.